Inheritance tax: How has the pandemic amplified its importance?

How much taxation is applicable in India on inheritance, and should the tax net around it be widened?

The COVID-19 pandemic is not only wreaking havoc on human lives but also the country’s finances. India had to swallow the bitter pill of a negative GDP and loosen its purse strings to finance economic recovery – be it the three relief packages of Rs 24.35 lakh crore released last year or the Rs 1400 crore spent on vaccines till March this year. 

There is unprecedented pressure on the government exchequer and, expectedly, talks of a revival of inheritance tax. A recent report by the Organisation for Economic Cooperation and Development (OECD) has fuelled this speculation. The OECD report recommended that governments consider bringing back inheritance tax to finance the COVID-19 setback. 

The Income Tax department, on its part, has recommended the reintroduction of inheritance tax at 55%, along with other measures.

What inheritance means in Indian taxation 

Inheritance tax has been defunct in India since 1985, during the time Rajiv Gandhi was Prime Minister. Subsequent governments have ruled out its reintroduction, questioning the merits of its levying instead. 

Inheritance: Presently, if you inherit an ancestral property in India, no taxes are applicable on inherited assets. While gift tax is applicable in India, any transfer or receipt through a will or inheritance is outside the scope of gift tax. 

Income from inheritance: However, inheritance can also be in the form of a source of income. Any income earned from the inherited property is taxable as if it were the income of the recipient. So, if you inherit the property worth Rs 1 crore from your deceased father, you will not be liable to pay any taxes. However, if the property generates a rental income of (say) Rs 1 lakh a month, the same will be taxable as Income from House Property. 

Related: How to manage inherited wealth?

Capital gain from the sale of inherited property: If the inheritor decides to sell, any subsequent sale of property will be liable for capital gains tax. However, the cost of acquisition of the predecessor will be admitted as an expense. For capital gains indexation purposes, the holding period will include both the predecessor and successor’s holding period. Indexation inflates the cost of acquisition in case of long-term capital gains, which lowers the capital profit and the tax incidence on the seller. 

Besides, income taxes can be rendered exempt if the investment of the sale proceeds is made in the right manner. This includes the purchase of up to two house properties of up to Rs 2 crore, and investment of up to Rs 50 lakhs in National Highway Authority of India (NHAI) or Rural Electrification Corporation bonds, with the sale proceeds of the inherited property.

Related: Here’s how women can protect their inheritance

Inheritance tax in the light of COVID-19

Going back to the relevance of inheritance tax on property in the post-COVID economy, there are several arguments in its favour. It can be used as a tool against wealth concentration and wealth inequality. From the administrative perspective, it is easier for the government department to collect estate tax revenue, and involves less paperwork compared to other forms of taxation. 

Internationally, countries like Japan and South Korea are among the ones that have the highest rate of inheritance tax, with the latter charging a tax rate of 50%. Even prominent first-world nations such as the UK and the US charge a steep 40% tax which is levied on inheritance. In India, the wealthiest 10% of the population holds 77% of the nation’s wealth, and 60% of people live below the poverty line. It is, therefore, somewhat odd that inheritance is not taxed in India. 

With a sharp fall in the corporate tax collections last year and the fiscal deficit being 36% worse in February than in the corresponding year, the relevance of inheritance tax is hardly surprising. The fact that Indian billionaires grew richer by 35% during the 2020 lockdown also gives a premise for the resurrection of wealth-based taxation like inheritance and wealth tax. 

However, the imposition mechanism of inheritance tax has to be designed effectively. Lessons may be learned from the inheritance tax collections of countries like the United States, where only 0.2% of its estates pay inheritance tax, although 10% of its richest citizens hold 80% of its wealth. If the government at all decides to compensate fiscal deficits by leveraging tax revenue, the challenge for it would be to evaluate its options and ensure smooth implementation of the same.